Plan Your Investment Strategies Around Both Your Current Taxes and Your Retirement Plan

Reaching a higher tax bracket can cost you money, but not in the way most people think. Making $37,951 instead of $37,950 in 2017 doesn’t mean the entirety of your money is taxed at 35%, just that last dollar. But finding yourself in a higher tax bracket does impact other financial factors based on your ordinary income, such as your capital gains tax rate.

When do you qualify for a 0% tax rate?

Your capital gains tax bracket is 0% if your ordinary income tax bracket is 10% or 15%; having a higher income means your capital gains are taxed at 15% (or 20% if you’re in the 39.6% tax bracket). So keeping within that margin for a 0% capital gains tax is essential, especially if you planned your ordinary income in such a way to access it. It’s also important if you are retired and make most of your income from capital gains: an unexpected 15% tax bill can upset your financial planning for years.

What should you do if you ‘make too much’?

Making extra money can rarely be considered a bad thing, but sometimes it can throw your planning out of alignment. If you were already on the slim upper margin of the 15% ordinary taxable income tax bracket and either a bonus or extra dividends tip you over the edge, you need to find a way to make that income not taxable. The best ways to do that are to reinvest it in a pre-tax account, like your traditional IRA or your 401(k) or SIMPLE IRA if you’re still employed. SIMPLE IRAs are a great choice because, even if you have to start making withdrawals once your 70.5 years of age, you can still make contributions.

There are a lot of retirement strategies out there, and a lot of them seem like they only have highly technical differences. Taken altogether, these different types of stocks, retirement plans, and tax benefits can make it seem like you have to follow one person’s plan to the letter or else get caught in the weeds. But if you examine one factor at a time, it’s much easier to choose a strategy that’s right for you. One of the most common factors in deciding a retirement plan strategy is whether you should look for dividends.

What do dividends matter?

Many large companies you can invest in, like Walmart, give their stockholders payments at the end of each quarter or year based on their profits. This means you get direct, semi-reliable income based on your investments, which can be a useful thing to have if your investments are one of your main financial backups.

But because those dividends are paid out, that money isn’t reinvested in the company and each share grows at a smaller pace. It also means you get that money whether you really need it or not, and it’s much easier to accidentally spend your dividends instead of reinvesting them.

If dividends have advantages and disadvantages, should you have them?

In a short answer, probably not. Companies that have dividends generally have smaller stock growth than they otherwise would, which means the stock is comparatively worth less and less than it would have been if they never used dividends. Dividends are also money that you’re regularly given and are taxable in a way that growth on unsold stocks aren’t. The reason why investing in companies that give dividends has historically been so popular was due to:

simplicity, since you receive that money without selling,

regularity, since dividends are paid out on a set schedule regardless of the size, and

comparatively reduced fees, since buying and selling fees used to be much higher.

But most of those reasons don’t hold true anymore, due to automated investment strategies and the Internet in general, which has reduced the fees for selling shares. Also, dividends are usually taxed as ordinary income, which is a higher rate than your capital gains tax rate. That, combined with the reduced profitable growth of stocks with dividends, means you are likely to both lose out on and owe more money. If you invest online, especially with a low fee company like Vanguard, selling stocks as you need the money is a better strategy.